View: Rising M&As can be a warning sign

Signs of vitality can also signal, however paradoxically, that the economic party may be coming to a close. One such measure of health is the level of merger and acquisition activity, which actually tends to peak just before the economy tips into a recession.

Bloomberg

July 25, 2018, 07:58 IST

By Stephen Mihm

How long can the economy keep humming along? Larry Kudlow, President Donald Trump’s economic advisor, believes that the good times are here to stay for the foreseeable future. He declared last week that growth could well continue until 2024.

If such a thing happened, the current expansion, which is already long in the tooth, would be the longest ever. Certainly, anything is possible. After all, aside from the much watched movements of the yield curve, there are few clouds on the economic horizon: Hiring continues apace; the stock market, while no longer charging forward, is hardly in correction territory; consumer confidence, though slightly lower, is still generally upbeat.

But signs of vitality can also signal, however paradoxically, that the economic party may be coming to a close. One such measure of health is the level of merger and acquisition activity, which actually tends to peak just before the economy tips into a recession. Given the record $2.5 trillion in merger activity in the first half of 2018, it’s worth wondering whether the expansion may well be past its prime.

It has been well demonstrated that merger and acquisition activity follows a cyclical path. In one noteworthy synthesis published in 2007, two researchers traced five waves of mergers and acquisitions over the course the preceding century. The first began in the late 1890s and continued until 1903, while the second spanned the late 1910s until 1929. After the Great Depression and World War II, a new burst of activity commenced around 1955 and peaked around 1970.

The next two waves came and went more quickly, the authors noted: One began in the early 1980s, peaking around 1987; the next accompanied the tech bubble, and ended in 2001. The researchers published their article in 2008, just as yet another flurry of mergers and acquisitions came to an abrupt, ignominious end. After several years of dormancy, M&A activity slowly recovered along with the larger economy. It is now at its highest rate ever.

In general, the authors found that these waves of activity emerged from the rubble of some previous economic disaster and coincided with a period of significant credit expansion and a major stock market boom. These waves also tend to be more beneficial for shareholders at the outset of the cycle. But as the intensity of the cycle increases, the reasons for pursuing mergers become less rational and more herd-like.

When these cycles end, they tend to end very badly. They don’t just conclude with a tidy, mild recession. The first merger wave ended in a “stock market crash [and] economic stagnation.” The second concluded with a brutal stock market crash followed by the Great Depression. The third was punctuated by another stock market crash plus an oil crisis and other unpleasantness. The fourth terminated with the crash of 1987, which was bad but wasn’t followed by a recession for another couple of years. Number five was succeeded by the collapse of the tech bubble, a recession and the 9/11 attacks.

As for the M&A wave that hit its peak in 2007? The authors didn’t have the benefit of hindsight, but we now know that it ended with the worst economic crisis since the Great Depression.

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